Abstract
In this paper we test the information content of risk-neutral density functions estimated by the method of Malz [1997. Estimating the probability distribution of the future exchange rate from options prices. Journal of Derivatives 5, no. 2: 18–36]. The main question is whether risk-neutral densities coincide with the subjective densities. We find that the forecasting ability of 1-month EUR/HUF risk-neutral densities can be rejected for the period 2003–2007. Higher moments are responsible for the poor forecasting ability. Our interpretation is that the standard deviation, the skewness and the kurtosis of the risk-neutral densities are significantly above the respective central moments of subjective densities. We also find that delta-hedged gains on purchased options are negative, and can be considered high compared with the transaction costs of delta hedging.
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